Time inconsistency and endogenous borrowing constraints

This paper studies the welfare of time-inconsistent, partially sophisticated agents living
under two different regimes, one with complete, unfettered credit markets (CM) and the
other with endogenous borrowing constraints (EBC) where the borrowing limits are set to
make agents indifferent between defaulting and paying back their unsecured loans. The
CM regime cannot deliver the first best because partially sophisticated agents would undo
plans laid out by previous selves and borrow too much. Somewhat counterintuitively, in
some cases, the EBC regime may deliver higher welfare than the CM regime. These
results speak to the academic debate surrounding the creation and functioning of the
CFPB (Consumer Financial Protection Bureau) in the U.S. and its implementation of the
ability-to-repay rule on lenders after the 2007-8 crisis. Such institutions generate
commitment publicly and may help time inconsistent agents economize on the costs of
private commitment provision.